The people of Indonesia, the world’s third most populous democracy, have voted for a new President. The incoming administration will face hard policy choices to address rising fiscal pressures and to implement much-needed reforms to deliver on the economy’s enormous potential.

GDP growth in the first quarter of 2014 moderated further to 5.2 percent year-on-year, from 5.7 percent year-on-year in the prior quarter. The slower growth rate is due partly to the macro stabilizing monetary and exchange rate policy measures that have been taken to move to a more sustainable current account footing and enhance investor confidence. However, exports have remained sluggish, in part due to the impact of the raw mineral export ban implemented in January.

Indonesia’s economic growth in 2014 is projected by the World Bank to be 5.2 percent, slightly lower than the 5.3 percent forecasted in the March 2014 IEQ. Lower government consumption than previously expected, slower credit growth and continued weakness in commodity-related income growth are likely to constrain GDP growth in the second half of 2014.

To achieve longer term goals such as lifting growth above 6 percent and reducing inequality, deeper structural reforms such as fuel subsidy reform and more infrastructure investment are crucial and would help share more broadly prosperity. In the absence of policy measures to support investment and productivity growth, the risks of a more structural deterioration in growth will mount.

Subdued revenue growth and rising energy subsidy costs have increased fiscal pressures, prompting a substantial revision to the 2014 Budget, under which the fiscal deficit is increased to 2.4 percent of GDP, up from 1.7 percent. The fiscal position remains vulnerable to any further rise in oil prices or weakening in the Rupiah, and the need to improve further the quality of spending and enhance revenue mobilization is becoming critical if Indonesia is to achieve its development priorities.

One of the important priorities for fiscal policy reform is to support the inclusiveness of future growth, mitigating the trend of rising inequality seen in Indonesia in recent years. With concerted action Indonesia can arrest the rise in inequality, including through policies which not only combat inequality but also support poverty reduction, such as upgrading rural infrastructure, expanding access to quality education and improving labor market mobility.

Safeguarding hard-fought poverty reduction and social protection progress in Indonesia calls for continuously enhancing the management of disaster risks. El Niño conditions could worsen the forthcoming forest fire “season”, calling for appropriate contingency planning, such as implementing a systematic approach to determining the start of the fire season and timely triggering of stand-by emergency status.

In addition to topical analysis of “El Niño, forest fires and haze” and “Inequality and Opportunity in Indonesia” this edition of the IEQ includes a discussion of “New purchasing power parity-adjusted estimates of Indonesia’s economy”.